The recipient does not pay gift tax
Receipt of a gift or bequests is not taxed, in other words, the value of property so received is excluded from the recipient’s gross income. However, after the date of transfer income generated by the property will be taxed to the recipient (donee). This is known as IRC Section 102 exclusion.
Section 102 also applies to a gift in trust. Assume that the trust is a non-grantor trust and as such a taxable entity (see What’s the difference between a grantor and non-grantor trust?). The trust would receive a gift in trust tax-free but would have to record any income generated from the gifted property (for example, dividends or interest payments) as gross income. Assume that the trust provides that all its net income is distributed to its beneficiaries. Under the conduit rules of Subchapter J, the trust is allowed a deduction for the required income distributions, and a corresponding amount will be added to the gross income of the beneficiaries. Under the traditional definition of fiduciary accounting income, capital gains are typically excluded from distributable net income (DNI) and, thus, are taxed at the trust level. The net effect is that the corpus (the original gift in trust) is distributed tax-free to the remainder beneficiaries.
However, Section 643 regulations expand on the ways that capital gains can be treated as income instead of principal. Amounts treated as income are eligible for a DNI deduction and are therefore possibly taxed at the beneficiary level instead of the fiduciary level. See Trust and Estate Distributions in 2020 May Provide 2019 Tax Savings.
The donor pays the gift tax
As note above, the donor is generally responsible for paying gift taxes. Let’s start with gifts that are not subject to gift tax at all, those include:
- Annual exclusion gifts (see below)
- Payments for some educational expenses
Payments made directly to a qualifying domestic or foreign learning institution for the education of an individual qualify for the educational exclusion under Section 170(b)(1)(A)(ii) of the IRC. - Payments for medical expenses
Payments that qualify for the medical exclusion include those made directly to a medical institution or care provider for the benefit of an individual. - Gifts made to certain political and charitable organizations for their use
These are covered under Section 527(e)(1) of the Internal Revenue Code. The gift must be used for the benefit of the organization, not passed on to anyone else. Eligible other tax-exempt organizations as well as others detailed under Section 501 of the tax code. The organization must be classified as tax exempt under federal law.
The most important item on this list is the annual exclusion. In 2022 for gifts up to an amount of $16,000 per individual donee (gift recipient) no gift tax return has to be filled out, and, consequently, no taxes are due. Married couples can combine their annual exclusions and gift $32,000 to an individual per year without incurring any gift tax liability. In this case, however, couples still have to file a federal gift tax return using IRS Form 709.
Even if a gift tax return was filed, the average taxpayer is unlikely to pay any gift taxes because of the generous life time exemption; $11.7 million for the 2021 tax year and $12.06 million in 2022.
Who pays gift taxes and how much?
What is meant by the uniform basis rule?
